Bond Investors Pursued Yield In The First Quarter

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Appetite for yield ruled taxables in March and the first quarter.

That was reflected in total returns for riskier debt. Flexible income funds led all taxables in Q1 with a 2.91% gain on average, on top of a 0.95% March gain, according to preliminary Lipper Inc. data.

High-yield bond funds were close behind, tacking on 2.75% in Q1 after a 0.97% March advance.

At the opposite end of the spectrum, Treasury funds lost 0.79% in Q1 and inched up 0.09% in March alone. Foreign bond funds lost 1.91% in Q1 and 0.03% in March.

Emerging markets bond funds lost 0.68% in Q1 after giving up 0.46% in March.

Many investors were wary of foreign bonds due to Italy's election in February and the March Cyprus banking meltdown.

"The pattern seemed to be that the lower you went in credit quality, the better you did in yield and the less interest-rate sensitive the security was," said Peter Palfry, co-manager of $1.7 billion Loomis Sayles Core Plus Bond Fund .

Korean Store Operator

Palfry benefited from that trend with a bond due May 9, 2017, from Lotte Shopping, a Korean supermarket-department store operator.

Its ratings were low investment grade, including a Baa1 by Moody's. The bond is Yankee-dollar denominated, issued in the U.S.

Powered by a Q1 price gain of 1.18, its total return was 1.94% vs. 0.22% for the comparable Treasury.

"There was more incremental upside in corporate credit that's in an economy showing better relative strength than the U.S.," Palfry said.

Still, some investors bought eurozone debt on the dips.

"Investors added incremental yield to their portfolios, where they felt there was price appreciation potential as well," Palfry said.

The yield curve steepened slightly in Q1 as the yield on two-year notes stayed flat at 0.25% while the yield on 10-year Treasuries rose 9 basis points to 1.87%.

The price rise on the long end showed that investors were rotating into equities. Investors grew cautious about long Treasuries in anticipation of eventual Federal Reserve interest rate hikes, Palfry said.

Palfry sees risk of U.S. GDP growth slowing in Q2 and Q3 as consumers react to tax hikes and due to the impact of the federal sequester.

He trimmed his Treasury exposure to take advantage of the market rally. He added to his asset-backed securities and his high-yield debt. He took profits in investment grade securities to buy more triple-B and double-B bonds.

He added to nondollar Mexican and Philippine government bonds. He also boosted an Italian position on a post-election price dip.

Tax-exempt funds eked out a 0.58% gain on average in Q1 despite all of their categories except short-term muni debt funds losing ground in March.

March was ruled by an increase in supply. Many issuers ramped up capital raising as a new fiscal year neared, said Ted Jaeckel, co-head of BlackRock's muni funds desk. Also, many retail muni investors sold securities to raise cash to pay tax bills.

The muni market should strengthen as the usual seasonal supply contraction occurs in June and July, Jaeckel said.

Meanwhile, investors' desire for yield will continue to push many of them into medium and lower investment grade debt, he added.

Jaeckel owned a 30-year Sanford Health bond with a 5% coupon, rated A+ by S&P.

Based on its price to call, the Sioux Falls, S.D.-based multistate health system bond's Q1 total return was 2.16% as its price rose to 110.16 from 109.16. "That was an impressive (price) move," Jaeckel said. "And we like yields in health care."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

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